Abe’s FDI bet yet to pay dividends

Shinzo Abe’s government is striving to lift barriers to foreign investment in Japan, and Asian investors are already making the most of the improving business environment. However, as Jacopo Dettoni reports, overall business sentiment among foreign investors remains subdued, although gradually improving.

Japan’s attitude towards overseas investment has often drawn criticism in the past as local companies actively chased opportunities abroad, while the domestic market remained well sealed to foreign investment.

Former EU trade commissioner Peter Mandelson emphasised this “paradox” in a visit to Tokyo in 2008, when he labelled Japan as “the most closed investment market in the developed world”.

Eight years later, the country's government has taken meaningful steps to increase its FDI appeal. As prime minister Shinzo Abe made FDI a key ingredient of his growth recipe, restrictions have been lifted and reforms pushed through.

Boosting investment

Public authorities such as the Japan External Trade Organization (Jetro) have been tasked with showcasing to would-be investors opportunities offered by the country’s huge economy, still the world’s third largest, and its deep scientific and technological know-how.

Despite these efforts, the road ahead is still uncertain. Japan’s overall stock of accumulated FDI remains by far the lowest among OECD countries, and investors’ mixed feelings over the ongoing changes at policy level are reflected in volatile FDI figures.

Japanese authorities are stepping up to the challenge and remain confident that the Abenomics reforms will eventually deliver on increasing the stock of accumulated FDI to somewhere around the Y35000bn ($309bn) mark and thus assert the country’s appeal in key sectors such as R&D, energy, healthcare and tourism.

Japan’s stock of FDI stood at $170.7bn, or 4.18% of GDP at the end of 2015, according to figures from Unctad, which is only a fraction of that recorded by other major world economies such as the US (31.2%), China (10.94%), Germany (34%), the UK (51.3%) or the OECD average (36.14%).

Two factors

The country’s historically poor performance in attracting FDI comes down to two main factors, says an expert group, led by the minister for economic and fiscal policy, which was tasked by Mr Abe with drafting policy recommendation for FDI promotion.

The first is low profitability. “Challenges include systems and practices peculiar to Japan, lack of human resources that play an active role in the global arena, and corporate governance,” the group wrote in a document published after meeting with foreign companies and interested parties on five different occasions in the first half of 2014.

Second, it said, were “high costs: cited as issues on the reverse side of low profitability are business costs, tax burdens, high time and labour costs”.

With these two issues in mind, Mr Abe outlined a number of reforms and measures aimed at improving the conditions for foreign investors in Japan and closing the competitiveness gap with its neighbours.

The government cut the corporate tax rate in different steps to the current 29.97%, from 37% in 2013. It pushed through a corporate governance reform opening up the board of Japanese companies to independent directors; drafted a Japanese version of a green card visa system for highly skilled foreign labour; further liberalised a number of key sectors such as energy, life sciences and tourism; and drafted a five-point roadmap to make the life of foreign investors easier.

The five points are to: overcome language barriers at retailers and restaurants; facilitate better internet connectivity; accommodate business jets at local airports; enhance the educational environment for expatriate children; and strengthen advisory and consultation services to support foreign businesses. The aim of these steps is to develop an environment for foreign-affiliated companies to do business easily and improve the living environment for international workers.

Mixed results

These measures have produced mixed results in terms of attracting FDI so far. The country recorded negative net FDI inflows for $2.25bn in 2015, down from a positive $2.1bn in 2014 and $2.3bn in 2013, according to Unctad figures.

“Overall, negative flow was higher, caused by large-scale capital recoveries by multinational enterprises, which is represented by Suzuki’s buying back of its stake held by Volkswagen of Germany – 19.9% or about Y500bn,” Jetro wrote in its Invest Japan Report 2016.

“Investments from Europe were significantly negative as a consequence of these capital recoveries, whereas investments from North America maintained the positive flow at the level of the previous year as a result of investments in the electronic industry by companies such as Amkor Technology, and investments in the tourism market, including Bain Capital’s acquisition of Ooedo-Onsen Holdings operating Japanese inns at hot-spring resorts.”

Rise of Asian partners

FDI inflows have bounced back in the first half of 2016, however, when they reached Y2600bn, increasing eightfold from a year earlier, according to Jetro figures. Investment from Asian partners has played a key role in shoring up FDI figures in 2016 and is gradually replacing waning commitment from Western investors.

Pledges by Asia-Pacific partners made up more than 55% of total announced investment into greenfield projects in the first nine months of 2016, up 33% from the same period in 2015, partly compensating for falling levels of US and European investment, according to figures from greenfield investment monitor fDi Markets.

“The increasing trend of direct investment in Japan from Asian countries is expected to accelerate in the future,” said the Jetro report.

Asian investors are particularly focusing on Japan’s tourism and energy sectors, which combined made up 85% of the $2.46bn of greenfield investment they announced in the first three quarters of 2016. Backed by the growth of the tourism market thanks to increasing visitor numbers from Asia, real estate investment trusts and other investment funds embarked upon strategies to acquire properties such as commercial buildings and hotels.

Overall, they announced nine new real estate greenfield developments worth $1bn in the first nine months of 2016, according to fDi Markets. At the same time, they announced eight projects worth more than $1bn in the renewable energy sector.

Still subdued

If Asia-Pacific investors are becoming more active players in the Japanese market, mirroring a trend across the continent for intra-Asia crossborder investment, sentiment towards Japan in the overall community of foreign investors remains somehow subdued, although gradually improving.

More than 40% of the 197 foreign investors surveyed by Jetro in mid-July said the business climate has 'somewhat improved', or had become 'significantly better', from 32.9% a year earlier. On the other hand, only 0.5% of the surveyed firms said the business climate is 'becoming worse', from 5.4% a year earlier.

However, more than 60% said the business climate 'has not changed much' in the previous 12 months, which highlights the room for improvement across the board.

“Foreign investors in the Japanese market can still face numerous challenges, many of which relate more to prevailing social practice rather than government regulations,” the US Department of State wrote in its 2015 Japan Investment Climate Statement.

“These include high tax rates, including social security taxes; an insular and consensual business culture traditionally resistant to M&A; a lack of independent directors on many company boards (although this is changing); and cultural and linguistic barriers. However, the current government is pursuing initiatives intended to address each of these challenges, and hopes these policies will contribute to an increasingly open and investor-friendly business environment.”

Mr Abe has lots of political room to move forward with his reform agenda. The election of Donald Trump in the US has also lifted some pressure off the yen’s shoulders as the dollar gained ground against all major currencies in November.

But it now appears time for foreign investors to make a move – and for domestic players to lift some of those soft barriers typical of the Japanese culture, which have often mitigated the real effect of government reforms on FDI.

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